March 9, 2011

March 9, 2011

The NASDAQ Composite Index daily chart below does not paint a pretty picture, and the waves of distribution in the face of QE2 manipulations appear to be producing a lot of volatility, which can create headaches for investors on both sides of this market. However, the evidence is building for a potential top of some magnitude in this market given the “mess” of distribution days we see in the NASDAQ chart over the past 7½ weeks. Whether QE2 will prevail in the end, sending the indexes to new highs, may remain an open question, but the prima facie evidence that is available to us now does not look constructive, and that’s all we have to go on. At the very least we would have to conclude that playing the long side of this market carries with it increasing risk and so taking a wait-and-see stance here is prudent. While the Libyan “crisis” seems to be taking up less and less prominence in the news headlines, and hence packs less of a “surprise,” we may begin to see what it is that is really driving the heavier selling volume over the past two weeks. Libya and Egypt may turn out to be little more than “selling alibis” for big investors. As the NASDAQ holds its 50-day moving average here, we await either a bounce or a break from here.

As the market chops around in what may well be a “chop and slop top,” precious metals like our old friend silver have continued to trend higher. Since the breakout in late February, silver has held the 10-day moving average very well, and it may be that it is telling us something as it continues to do so even with the so-called fear bid from the so-called Libyan crisis moving into the background. My view is that the action in precious metals may be a clue that trouble is brewing ahead. When we consider that the Republicans are proposing about $57 billion in cuts while the Democrats counter with their own rather tepid $4.7 billion in budget cuts in a $3.5 trillion 2011 government budget that includes an all-time record $1.6 trillion budget deficit, it appears that politicians are in denial about the looming fiscal crisis that will continue to weigh on the dollar. Paper fiat money is out, “real” money in the form of “specie,” e.g., silver coins, is in – at least that’s how I see it. In the end, what politicians remain in denial about is what the market will eventually end up exposing. Recall Fed Chief Ben Bernanke’s assurances in 2008 that the “sub-prime crisis remains well-contained.” The markets then exposed him as either a liar or a know-nothing. Today he assures us that the Fed is “not printing money,” but the markets may again eventually prove otherwise.

Other signs of a market in distress are seen in the action of leading stocks which have broken down from late-stage bases, the most recent being our old friend, Netflix, Inc. (NFLX). NFLX failed to hold its bounce off the 50-day moving average from last week and over the past two weeks has come crashing down through its 50-day moving average. As I see it, NFLX looks to be developing into a potential Late-Stage Failed-Base(LSFB) short-sale set-up, given its long price move in this bull market that began exactly two years ago today. Generally, an LSFB set-up will fail on an attempted breakout from a late-stage base as it breaks down through the breakout point and the 50-day moving average and then attempts to bounce one or more times. Here we see that NFLX has broken the 50-day and is headed for one of three logical “support” areas. The first is the trendline breakout at #1, the second is the bottom of the gap-up day of January 27th at #2 which sets up a “fill-the-gap” rally possibility, and #3 is the lows of the prior base, which could set up an “undercut & rally” situation. It is likely that we will see one or more rallies back up into the 50-day line before it finally splits wide open, and these rallies would logically occur off of one or more of these support areas. Eventually, I would look for NFLX to move down to its 200-day moving average at 158-159.

Last week I began discussing some of the initial potential short-sale set-ups I was seeing in the “big stock” cloud-computing names like Salesforce.com (CRM), shown below on a daily chart. Remember that when it comes to shorting, we want to focus on leading stocks from the immediately prior bull phase that are starting to break down as our target shorts. It is from this pool of potential shorting candidates that you will find your best short-sale plays, and this is often a process of monitoring and “massaging” short positions in these stocks as they begin to break down. CRM is still relatively early in a potential LSFB short-sale set-up, and it is possible that we could see another rally up towards the 50-day moving average, but so far the stock isn’t showing any inclination to do so yet. If you’re short this thing on the break from last week, then you need to be alert to the potential for such rallies, although in my view it is likely and ultimately headed for its 200-day moving average and the top of its prior base from November of last year, as I’ve highlighted on the chart.

F5 Networks (FFIV) is still panning out as a head & shoulders top formation, and at this point it is much more well-developed as it rolls over to clearly form a big right shoulder in this pattern. As we see on the daily chart, the huge-volume break off the peak defines the right side of the “head” in the H&S formation, and near-term we can see “logical” support areas at the 200-day moving average around the 104-105 price level, or the neckline of the H&S pattern down below the 100 price level. FFIV could continue to build more right shoulders in the pattern, but this will likely depend on the action of the general market. Currently, with the NASDAQ resting on its 50-day moving average, as we saw further above in this report, the potential for a “logical” bounce is certainly there, and this might see some of these cloud-computing short-sale target stocks join in by bouncing themselves. If the NASDAQ breaks the 50-day moving average in the next day or so, then these will likely make a break for the near-term support areas as I’ve outlined them here in FFIV’s chart and the others above.

Further evidence of a troubled general market will be found in continuing breakdowns in leading stocks. Over the weekend I liked the action in JDS Uniphase (JDSU) as it exhibited a strong pocket pivot buy point, but that came apart very quickly on Monday and then even more today as its peer in the optical networks area, Finisar Corp. (FNSR) came out with earnings, guided below expectations, and got absolutely decimated as we see on its daily chart below. JDSU’s wobblings on Monday were probably the first sign to back away, and it may be that the market knew trouble was coming in FNSR going into Tuesday after the close. FNSR, however, is a good example of what you want to be looking for as you build your list of potential short-sale candidates if the market continues in a correction or even an outright bear market. Today’s massive-volume 38.54% price break defines the right side of the “head” in a possible H&S top formation. From here the stock will likely attempt to stage a dead-cat bounce to form a right shoulder in the pattern, so this is something to monitor as you place FNSR on your short-sale watch list waiting for the pattern to develop further.

Last week we had what we now know to be not a “follow-through” day but what I like to call a “phollow-through” or phony follow-through day as Monday’s sharp distribution put an end to last Thursday’s rally attempt. With the major market indexes still holding above their 50-day moving averages it is not clear whether we are in a position for a bounce here. Last May I made around 100% in my own account hitting the short side not too long off the peak back then as QE1 came to an end in April, and the key in shorting is to wait for the right window to develop. For now your best short-sale targets will be broken-down former leaders like NFLX, CRM, FFIV, and LVS, which I’ve discussed in recent reports. As more leaders break down we will likely see more right sides of “heads” in potential head and shoulders formations show up as well as more late-stage base-failures in leading stocks that are still holding above recent breakouts. It is from these stocks that you will build your bear market short-sale watch list, so choose your set-ups carefully. For now I tend to take a tactical, shorter-term approach to short-selling as I keep a close eye out for movements down into logical support areas. This, a fluid concept however, as it all depends on the action of the general market. Members should refer to Chapter 6 of “Trade Like an O’Neil Disciple” which is titled “Riding the Bear Wave: Timely Tools for Selling Stocks Short” for a broader understanding of short-selling and the proper “windows” for doing so. In the meantime, don’t go hog-wild on the short side unless you have plenty of experience doing it, as much of the short-side of this market is still in the early developing phase and we cannot be sure whether QE2 manipulations will be a factor at any point here.